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Wei Linchao

Wei Linchao

Dropship and Logistics Specialist, the founder of Bestfulfill that help you with order fulfillment from product sourcing, shipping, branding, and customized package.

Do You Need an LLC for Your Drop Shipping Business?

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As of 2021, the estimated value of the dropshipping market segment stood at over $149.1 billion, with projections showing that by 2025, the dropshipping segment will be worth over $557.9 billion.

To get a part of this enormous pie that is the dropshipping market, one of the most critical decisions you will need to make is whether to operate as an LLC or an individual (sole proprietor) or any other business model.

  • Should you create an LLC, and if so, when should you form an LLC when running a dropshipping business?
  • What should influence your decision to establish an LLC or not?
  • How do you set up an LLC for your dropshipping business?
  • What are the estimated costs of setting up an LLC?
  • What benefits can you expect from running the LLC?

By the end of this article, you will have answers to all these questions.

We’ll start from the beginning

Do You Need An LLC For Your Dropshipping Business?

If you want to limit personal liability and protect personal assets, you need an LLC. If you want your business to have legal recognition, you need an LLC as soon as possible.

On the other hand, if you want to run your Amazon dropshipping business as a side hustle, you do not necessarily need an LLC. You don’t need an LLC if you do not want to file separate tax returns—for yourself and your LLC.

However, this answer is not simple. Whether you need an LLC depends on your unique situation in life, whether the benefits attached to an LLC make sense to you and your new business, and various other factors that you will discuss later in this article.

1: LLC Benefits for an Amazon Drop Shipping Business

Do You Need an LLC for Your Drop Shipping Business?

The main benefit of LLCs is that LLCs are legally-recognized business entities separate from the owners/founders.

Additionally, they are taxed as legal entities the same way as general partnerships or sole proprietorships because the owners include the company’s losses or profits in personal tax returns. The only difference is that LLCs are never indebted by taxes and are offered various tax classifications to select from. LLCs can also opt to get taxed like corporations, but this rarely happens. 

These and other flexible options make LLC’s attractive to Amazon dropshipping startups. 

Other notable benefits include:

1:1: Limited Liability Protection

One of the main benefits of forming an LLC for your dropshipping business is the LLC’s personal asset protection capabilities, also referred to as limited liability protection. 

With this protection, if your business suffers losses, falls into debt, defaults, faces bankruptcy, or if you face a lawsuit linked to a faulty, substandard, or knock-off product, no one can recover your personal assets to compensate for any shortfalls or monetary misunderstandings. 

The personal assets placed out of reach may include your house, car, personal bank account, or any other investments you possess not directly linked to your dropshipping venture. The LLC structure also extends personal asset protection if any of the products you sell cause personal injury, property damage, libel, and copyright infringement. 

However, the protection legally applies if you register your LLC immediately after setting up your business and before your first sale. Also, your entity should have maintained compliance throughout the period you have been in operation to ensure the scope of any recovery only targets business assets.  

1:2: LLC Tax Benefits and Other Amazon Dropshipping Options

The mode of taxation for LLCs is identical to a pass-through business venture—also applied to sole proprietorships and general partnerships and also called flow-through entity taxation. This means the net income of your dropshipping business pays its taxes using an individual tax code instead of through a corporate tax code. 

The pass-through tax option saves your business tax overhead costs because, first, LLC tax is calculated depending on your individual tax rate, which means your LLC tax will be flexible and vary. 

To understand this concept better, let’s take the example of C-Corporations, where profits are taxed twice, at the corporate level and a personal level after profit-sharing among owners – while LLC’s taxes are only on the personal level. LLCs can also select the C-Corporation tax system, but it is not a popular choice for obvious reasons.

Another benefit of the pass-through system in lowering taxes even further is that most LLC owners sometimes deduct around 20% of their business earnings before filing tax returns. Consequently, tax is still calculated based on your personal income rate, which could roughly range between 10%-37%. Therefore, the final tax rate is based on the current income in hand and your unique filing status.  

1:3: Enhanced Business Credibility, Name Uniqueness and Consumer Trust

Operating an LLC provides credibility to your Amazon dropshipping business and gives the impression you are serious about your venture and aware of what you are doing. This builds customer trust and brand visibility than when your business operates informally. 

A registered unique LLC name can become a recognized brand over time, attracting loyal clients and referrals, which will provide a steady stream of business to your company.  

The credibility of your LLC’s branding can also be beneficial when applying for credit, business loans, or grants.  

2. The Best Time to Form an LLC for Your Drop Shipping Business

The best time to form an LLC is as soon as you begin your dropshipping business because it ensures you enjoy all the benefits associated with an LLC right from the onset. 

If that is not possible, you can start small as a sole proprietorship then later register an LLC once your business is up and running. 

Here are some signs you can use to determine when it’s time to register an LLC for your Amazon Dropshipping business:

2:1: Business Structure

When launching your Amazon dropshipping business, the structure you choose is crucial because it influences all aspects of your startup. It influences how you conduct your day-to-day operations, the amount of tax you pay, to how your businesses’ liability may affect your personal assets. It is always advisable to settle on a structure that balances the demands of your business, personal investments, and third parties – clients and employees. 

Apart from taxes and liabilities, the structure you choose should also consider the amount of seed capital required for your business to take off, the paperwork involved, the licenses and permits you need to apply to ensure your business operates legally. 

Although an Amazon dropshipping business offers a few business structural options, beginning with an LLC comes highly recommended for small and mid-sized ventures. This is because an LLC structure separates your business activities from your personal assets to offer liability protection.  

2:2: Scale of Your Entity

If you start your dropshipping business as a sole proprietorship on an experimental basis before forming an LLC, consider how long it has been in operation before you fully commit. 

For example, if you launched the business recently, give yourself ample time to weigh present circumstances accurately and predict near-future prospects to establish if it is heading in the right direction. 

If you have been in operation for a considerable time and you can see a positive difference from when you began, such as an increase in business volumes and regular customers, take the opportunity to transform your business into an LLC. 

However, the two indicators are still not adequate signs: allow your business one to three more months to observe if the increased business volumes and clients maintain the steady flow, to leave no doubt. 

Another way to ensure your business is stable and ripe for LLC registration is posting fairly good after-tax profit margins that can sustain your expenses and still leave ample sums to invest or save –consistently for about three consecutive months. 

2:3: Time of Establishment 

As explained in the previous point, the duration of your operation can provide vital clues if the time is right to register your business as an LLC. The key is to pay close attention to changing business patterns, compare with past trends, and note how long they last, depending on how old the business is. 

When you notice a raised flat curve on your graph that has extended for a decent length of time, it should be the green light you have been waiting for to make your move to form an LLC.

2:4: Risk Assessment 

Assess if your line of business is in the high-risk category. Are you dealing with sensitive products that pose potential hazards to your clients and their property? Or fragile, easy-to-damage merchandise? Or high-value products that are possible to counterfeit? 

If the answer to all the above questions is yes, you should not wait to register your dropshipping business as an LLC. Every day you operate as a sole proprietorship, you take a huge risk on a personal and business level. 

An Amazon dropshipping startup that deals with risky products should be registered as an LLC from day one to protect your business, personal assets, and third parties.     

2:5: EIN Number

An Employer Identification Number (EIN) is a mandatory legal requirement by the IRS for all online businesses. The EIN works along the same lines as a Social Security Number, and the IRS only issues it to legally registered companies. 

The unique number it bears represents your business and is a reference point when filing taxes’, opening your venture’s bank account, officially registering your business, or any other transactions involving your company. 

You have to ensure all your sales, agreements, contracts, purchases, payments, and other business-related activities relate to your entity through the EIN.  

2:6: Finances

It is always best to separate business and personal finances at all costs: It makes you look professional and makes it easier to track your business growth and determine if you’re posting profits or losses. Blurring the lines of the two accounts can end up being a costly mistake if matters take a turn for the worse. 

3: LLC Alternatives

Despite most online Amazon dropshipping business ventures preferring the LLC structure, other models exist for startups, which include;

  • Sole Proprietorship: This simple business model forms the most basic structure and is ideal for small entrepreneurs who transact equally minimal volumes. A sole proprietorship does not accord limited liability safeguards and exposes your personal assets if things go awry. Tax filing involves only reporting your earnings as you file personal tax
  • S-Corp: Also called an S subchapter, a business must have passed through the S-Corp or LLC model before being registered in this category. S-Corp offers limited liability protection just like LLC, and if business shareholders are one hundred or less, they can be placed in the partnership tax bracket. It is also not uncommon to find businesses using both S-Corp and LLC structures simultaneously
  • C-Corp: Business shareholders and owners in this group are subject to double taxation: on a personal level when they receive their share of profits and on a business level on the total profit earnings. The owners and shareholders benefit from separating their assets and the corporation’s income. This arrangement is called maximum limited liability, and the investments amounts involved are usually significant.

Conclusion

An Amazon dropshipping business provides endless opportunities, can be operated from anywhere with an internet connection and requires minimal capital to begin in most cases. It is also possible to run it as a side-hustle to supplement your main income.

Most people prefer to begin their startups when conditions are considered perfect, but this is not necessary with an Amazon dropshipping business. You can begin at any moment with the little you have – grow and learn from that point forward.  

FAQ

1. What are the costs involved in an LLC startup? 

LLC registration costs and requirements vary between different states. However, the initial filing fee plus either an annual or biennial fee can range between 40-$500, while the average LLC seed capital is around $132.

2. Is an LLC mandatory when dropshipping on Amazon?

No, it is not. You can opt to begin at the sole proprietorship level and work your way up according to the performance of your business. 

3. Is it necessary to register an LLC to receive payments on Shopify?

No, it is not. However, it is necessary to own a legally registered business venture. Shopify payments require your EIN and bank account details.

4. What is the process involved in setting up a dropshipping LLC? 

  1. Step 1 – Select the state you intend to launch your business
  2. Step 2 – Come up with a unique name for your LLC
  3. Step 3 – Find a registered agent to help with registration
  4. Step 4 – File the LLC with your preferred state
  5. Step 5 – Draw up your LLC Operating Agreement
  6. Step 6 – Apply for an EIN
  7. Step 7 – Get your own physical US mailing address if you are outside the US
  8. Step 8 – Open a US bank account

6. How does an Amazon drop shipping business make money?

By buying products at a low price (mainly from manufacturers or wholesalers in China), shipping them to Amazon’s warehouses through its FBA program then listing the products on Amazon for sale – Amazon will take care of the rest. 

You could also opt to fulfill the products outside of FBA, although that could easily increase your involvement in the business and make it harder to manage. It is best to take advantage of Amazon’s infrastructure and network of warehouses.

7. Is an LLC only comprised of several owners?  

No. It is possible to register a single-member LLC, which also enjoys the limited liability protection of an LLC made up of many owners or shareholders.

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